New Estimates of the Future Path of 401(k) Assets
By
James Poterba
MIT and NBER
Steven Venti
DartmouthCollege and NBER
David A. Wise
HarvardUniversity and NBER
April 2007
Abstract:Over the past two and a half decades there has been a fundamental change in saving for retirement in the United States, with a rapid shift from employer-managed defined benefit pensions to defined contribution saving plans that are largely controlled by employees. To understand how this change will affect the well-being of future retirees, we project the future growth of assets in self-directed personal retirement plans. We project the 401(k) assets at age 65 for cohorts attaining age 65 between 2000 and 2040. We also project the total value of assets in 401(k) accounts in each year through 2040 and we project the value of 401(k) assets as a percent of GDP over this period. We conclude that cohorts that attain age 65 in future decades will have accumulated much greater retirement saving (in real dollars) than the retirement saving of current retirees.
The research reported herein was pursuant to a grant from the U.S. Social Security Administration (SSA) funded as part of the Retirement Research Consortium . We also received funding from the National Institute of Aging through grant P01 AG005842 to the National Bureau of Economic Research. The findings and conclusions expressed are solely those of the authors and do not represent the views of SSA, any agency of the Federal Government or the NBER.
Page 1 of 31
Over the past two and a half decades there has been a fundamental change in saving for retirement in the United States, with a rapid shift from saving through employer-managed defined benefit pensions to defined contribution retirement saving plans that are largely controlled by employees. In 1980, 92 percent of private retirement saving contributions were to employerplans; 64 percent of these contributions were to defined benefit plans. By 2000, about 87 percent of private contributions were to plans in which individuals decide how much to contribute to the plan, how to invest plan assets, and how and when to withdraw money from the plan. Following the 2000 stock market decline, this proportion declined somewhat as employers made "catch-up" contributions to under-funded DB plans.
In this paper we consider how the change in the way people save for retirement will affect the well-being of future retires. We project the future growth of assets in self-directed personal retirement plans. The most important of the large number of personal retirement plans is the 401(k). We consider not only 401(k) plansper sebut 403(b), section 457, and related tax-deferred retirement saving plans, as well as traditional defined contribution plans. We refer to all of these plans collectively as "401(k)" or as “401(k)-type” plans. In a companion paper, Poterba, Venti and Wise (2007a), we consider the future decline of assets in defined benefit plans.
Our analysis is based on cohort data on individual 401(k) participation rates. We use these data as a foundation from which to project401(k) participation rates and asset accumulation in the future. These projections are combined with the Social Security Administration's demographic forecasts to project the stock of 401(k) retirement plan assets in each year between 2006 and 2040. And we project the accumulated 401(k) assets at age 65 for all cohorts attaining age 65 between 2006 and 2040
Other studies have also based projections on individual data. Holden and VanDerhei (2002a, 2002b) project the evolution of the proportion of pre-retirement income that will be replaced by 401(k) asset accumulations. The studies simulate 401(k) assets by projecting the future accumulation of assets held in 2000. Because their sample consists only of plan participants, their projections do not consider the future increase in 401(k) participation rates and do not consider future demographic trends. Two studies by the Congressional Budget Office (2004a, 2004b) develop a framework to project asset flows into and out of defined benefit (DB), defined contribution (DC), and IRA plans. These analyses are based primarily on the 1997 Information Returns Master file from the IRS, supplemented with data from the Survey of Consumer Finances, Form 5500 data, and other sources. The studies project DC balances by assuming that future participation and contribution rates will equal the age-specific rates observed in 1997. These studies also do not consider the future spread of 401(k) plans or the effects of demographic trends on the accumulation in personal retirement plans.
The paper is organized into fivesections. In the first section, we describe the spread of 401(k) saving programs since these saving plans first became widely available in the early 1980s. In the second section, we explain how we project the level of future assets in401(k) plans. We detail key assumptions about employment trends, participation rates, contribution rates, as well as withdrawal patterns once 401(k) participants reach retirement. In section 3 we present projections of 401(k) assets at retirement (age 65) for each cohort that retires between now and 2040. In addition we project the total value of assets in 401(k) plans by year, through 2040. We also compare projected assets in 401(k) plans with the declining benefits from DB plans. In section four, we summarize our results and discuss the implications of the findings.
- The Spread of 401(k) Plans Between 1984 and 2003
We use data from the Survey of Income and Program Participation (SIPP) to track the spread of 401(k) plans over the past two decades and to develop projections of future 401(k) assets. Various SIPP surveysprovidedata on eligibility for and participation in 401(k) plansin 1984, 1987, 1991, 1993, 1995, 1998, and 2003. Each SIPP survey is a random cross-section sample of the population. The cross-section data from the SIPP surveys can be used to create “synthetic” cohorts. For example, to construct cohort data for the cohort that was age 25 in 1984 we use the 1984 panel to obtain data for persons 25 in that year, the 1987 panel to obtain data for persons who were 28 in that year, the 1991 panel to obtain data for persons who were 32 in that year, and so forth. The cohort that was age 25 in 1984 was age 44 in 2003. We sometimes label a cohort by the age of the cohort in 1984 and sometimes by the year in which the cohort attains age 65. For example, the cohort that is age 25 in 1984 attains age 65 in 2024 and is referred to as the C25 or the R2024 cohort.
The unit of observation in the SIPP is the individual and most of our calculations are performed at the level of the individual. In addition, we sometimes present results for families by grouping individual responses, treatingunmarried persons as single-person families and matching spouses to create two-person family units. A family is eligible for (or participates in) a 401(k) plan if at least one member of the family is eligible for (or participates) in a plan. The "age" of a two-person family is assumed to be the age of the male spouse.
We first consider data on family eligibility, organized by cohort. The SIPP provides some data for 54 cohorts. Figure 1-1a shows these data for 9 cohorts, five years apart, denoted by the age of the cohort in 1984. Consider cohort C25 that was 25 years old in 1984.In 1984, about 7 percent of the C25 cohort families were eligible for a 401(k) plan. By 1987, the percent of this cohort that was eligible for a 401(k) plan had risen to about 20 percent. By 2003 this cohort is over 40 years old and eligibility was slightly more than 70 percent. The most important feature of the figure is the increase in eligibility over time for families of a given age. For example, the dashed vertical line highlights the increase in the eligibility of families in cohorts that attained age 40 insuccessively later years. Cohort C40 was 40 years old in 1984 and about 16 percent of the C40 cohort was eligible for a 401(k) at age 40. Cohort C35 attained age 40 in 1989 and about 34 percent of the C35 cohort was eligible for a 401(k) plan at age 40. The C25 cohort was age 40 in 1999 and almost 70 percent of the C25 cohort was eligible for a 401(k) plan at age 40. Similar increases in eligibility are evident at other ages.
Figure 1-1b shows eligibility data for every other cohort for which data can be obtained from the SIPP. Figure 1-1c shows data for every cohort, from C11 to C64. The youngest cohorts are shown in the upper left of the figure and the oldest are shown in the upper right.[1] Again, the dashed vertical lines highlight increases in eligibility for cohorts that reached given ages in successively later years. In Figure 1-1b, it is clear that with few exceptions cohorts that reached a given age in successively later years had successively higher 401(k) eligibility rates. The same pattern is shown in Figure 1-1c, with surprisingly few “cross-overs” in the individual cohort trends even though in this figure each successively younger cohort, from bottom-right to top-left in the figure, is only one year younger than the prior cohort.
The increase in eligibility rates reflects the spread of 401(k) plans to more firms and especially to smaller employers. As described in Poterba, Venti, and Wise (2004), for example, a large fraction of employers who first adopted 401(k) plans in the early and mid-1980s also offered DB plans; few of these employers discontinued the DB plan when the 401(k) plan was adopted. Employers who instituted 401(k) plans later were less likely to have existing DB plans and were typically smaller firms.
The participation rates in 401(k) plans show patterns similar to those for eligibility rates. Family participation rates in 401(k) plans are shown by cohort in Figures 1-2a, 1-2b, and 1-2c. As in the eligibility Figures 1-1a, 1-1b, and 1-1c, the dashed vertical lines highlight the increase in the participation rate of families who attained a given age in successively later years. For example, Figure 1-2a shows that only about 10 percent of the C40 cohort, those who were age 40 in 1984, participated in a 401(k) plan. But over 50 percent of the C25 cohort, which attained age 40 in 1999, participated in a 401(k) plan. More detail is shown in Figures 1-2b and 2c. Figure 1-2b shows participation rates for every other cohort and Figure 1-2c shows participation rates for each of the cohorts for which data are available in the SIPP.
The cohort figures show a very large increase in 401(k) eligibility and participation rates between 1984 and 2003. In particular, cohorts that reached a given age in successively later years had successively higher eligibility and participation rates. The increase in eligibility and participation rates at selected ages between 1984 and 2003 is summarized in Table 1-1. The table shows the eligibility rate and the participation rate for cohorts in the age intervals 30-34, 45-49 and 60-64 in 1984 and 2003. While only 14.8 percent of the cohort age 30-34 in 1984 was eligible for a 401(k) plan, 66.8 percent of the cohort that attained age 30-34 in 2003 was eligible. Only 8.2 percent of the cohort that attained age 30-34 in 1984 participated in a 401(k) plan, but 53.9 percent of the cohort that attained this ageby 2003 participated.
The table also shows the percent of those eligible who participated in 1984 and 2003. For each age, the participation rate given eligibility increased very substantially over this period. For example, in 1984, 55.5 percent of eligible familieswith heads aged 30-34 participated in a 401(k) plan. By 2003, 80.7 percent of those who were eligible also participated. Of families with heads aged 45-49, participation given eligibility increased from 68.6 percent to 85.9 percent between 1984 and 2003.
More detail on participation given eligibility is shown in Figure 1-3. The figure shows that, given eligibility, the participation rate increased between 1984 and 2003 for all age groups, especially for younger age groups. The figure also shows that in 2003 the participation rate given eligibility was about the same (80 percent) for each of the age intervals from 40-44 to 60-64. The dataalso suggestthat participation rates given eligibility are higher for younger cohorts.
The rapid spread of 401(k) eligibility and participation rates has resulted in very rapid growth in aggregate contributions to 401(k) plans. Figure 1-4 shows contributions to 401(k) plans and, for comparison, to all other private pension plans from 1975 to 2002.[2] Contributions to 401(k) plans are shown by the lined bars. Contributions to 401(k) plans were first made in 1982. By 2000, total contributions to 401(k) plans had reached $182 billion and accounted for 73 percent of contributions to all private pension plans. Counting IRA, Keogh, and traditional employer provided non-401(k) DC plans, 87 percent of contributions were to personal accounts. This percentage fell to 61 percent by 2002 because of unusually large DB catch-up contributions triggered by the decline in the stock market.
The increase in total pension plan contributions between 1982 and 2000 was accounted for almost entirely by the increase incontributions to 401(k) plans. Contributions to defined benefit (DB) plans fluctuated substantially over this period, but were about $15 billion, or 31 percent, lowerin 2000 than in 1981 before increasing in 2001 and 2002 in response to the stock market decline. Contributions to non-401(k) defined contribution (DC) plans changed little between 1981 and 2002. There was a substantial spike in IRA contributions in 1982 through 1986. Thereafter IRA contributions fell by about 75 percent, when the tax advantage of IRA contributions was reduced for a small proportion of contributors. Since 1987, the sum of IRA and Keogh plan contributions has changed very little. Most of the inflows to IRAs today are roll-overs of previous accumulations in defined contribution accounts, rather than traditional contributions.
2. Projecting Future 401(k) Contributions
We first set out the calculations that are the basis for our projections of 401(k) wealth. We denote persons by the subscript. Cohorts are denoted by subscript . Associated with each person in each cohort is a lifetime earnings profile. The earnings of person in cohort at age are denoted by. The zero-one indicator that person in cohort participates in a 401(k) plan at age is denoted by, the rate of return earned on 401(k) assets that were held at the beginning of the year when the person attained age a is denoted by, and the contribution rate is denoted be(expressed as a proportion of earnings). The value of the 401(k) assets held by person in cohort c at age a is given by
(1)
where and where is the contribution rate. This calculation is made for every person (i.e. earnings history) for every age in every cohort. In practice, separate calculations are made for wealth in stocks and bonds and the assumed rates of return do not vary by individual. In particular, the 401(k) wealth of person in cohort at 65 is given by
(2)
This accumulation is calculated for each person (earnings history) in our sample.
We then obtain the average wealth held by the population of all persons age 65 for a cohort. To do this we need to know how many persons of type arein the population. Denote the number of persons with lifetime earnings profile i in cohort c at age 65 by (to be determined by population projections). Then the average of 401(k) assets held by all persons in cohort c at age 65 is given by
(3).
where J is the number of persons (earnings histories) in the sample. In practice, we don’t have population forecasts associated with each earnings history in the sample. Instead, we project total assets using population projections for groups of persons with the same demographic characteristics. The Office of the Actuary of the Social Security Administration has developed population projections by calendar year and age and by gender and marital status. Each earnings history in our sample can also be identified by the gender and marital status of the person. We first calculate the average ofseparately for each of the four gender-marital status pairs and denote this average by. Then the average wealth at 65 for each cohort is determined by
(4)
where the sum is over the four gm (gender-marital-status groups) and the number of persons in each of these groups is taken from the Social Security Administration demographic projections.
We also present projections of total 401(k) assets in each year through 2040. To do this, we use the identity that the wealth of person in cohort in calendar year is given by
(5)
Then, the total value of assets held in 401(k) accounts in year y is given by
(6)
To implement these calculations we need to develop projections of future 401(k) participation rates and earnings and we need to make assumptions about future 401(k) contribution rates, rates of return, cash-out probabilities, and 401(k) withdrawals. We begin by describing projections of average 401(k) participation rates for each cohort. We then describe the other assumptions that are needed to obtain estimates of 401(k) asset accumulation.
Participation rates: We use SIPP data for 1984, 1987, 1991, 1993, 1995, 1998, and 2003 to track the spread of 401(k) plans over the past two decades and to develop projections of future 401(k) participation rates. We sometimes label a cohort by the age of the cohort in 1984 and sometimes by the year in which the cohort attains age 65. For example, the cohort that is age 25 in 1984 attains age 65 in 2024 and is referred to as the C25 or the R2024 cohort. These calculations are based on the person data as reported in the SIPP. For the figures discussed above we combined these person data to form families.
We begin with historical participation ratesfor individuals by cohort, as shown in Figure 2-1. The earliest SIPP data are for 1984 and the most recent data are for 2003. We will use these data to project 401(k) participation at ages 25 through 65 for a large number of cohorts, ranging from the cohort that attains age 65 in 1982 through the cohort that attains age 65 in 2040. Only a few of the cohorts (shown in the bottom right of Figure 2-1) had attained age 65 by 2003. Thus for all but a few of the cohorts we must project participation rates from the last observed age in 2003 to age 65.
The participation rate is the eligibility rate times the participation rate given eligibility. The future eligibility rate will depend in particular on the spread of 401(k) plans to small employers. We know that eligibility rates have increased very rapidly over the past two decades, and that participation, given eligibility, increased substantially over the 1984 to 2003 period, as shown in PVW (2004). We have not found a compelling way to formally project future rates of eligibility or participation conditional on eligibility. Thus we have simply made “plausible” assumptions about future participation rates and use them to project future cohort participation rates for persons in cohorts not covered in the SIPP data.